 I'm sure that when you looked at the program and you saw the title of this of my talk today Pencils and visible hands and broken windows. You must have wondered what in the heck is this guy going to talk about? It seems kind of an odd title for an intro lecture into economics But it actually fits in very well because the pencil The invisible hand and the broken window are actually three very important Demonstrations that have existed in economics That give you really a strong starting point for economic analysis It really these three little parables of sorts give us the foundation of Understanding the economy of where we're coming from the world around us and the subsequent topics that are going to be discussed here today These are also three stories that are very old The invisible hand goes back 250 years The broken window story goes back more than 150 years and the eye pencil story has been around for about 50 years So they're very They're old But they're also trusted and sort of tested out stories in terms of giving us a feel for the economy how it works and why sometimes it doesn't and in each case with the pencil the invisible hand and the broken window we have Applications to what's going on in the world today that we can link these stories to So that we can get a feel for an understanding of what's really going on in the economy now the invisible hand is the oldest of the stories and This was inaugurated by an economist philosopher from Scotland named Adam Smith and Smith used the phrase invisible hand to refer to how the market economy worked he basically said that in terms of the economy and business people That we could rely on their self-interest All's all's they had to do was to follow their self-interest and no matter what they did Everything would turn out. Okay That workers would be taken care of The consumers would be taken care of and We wouldn't have to have anything else All we'd have to rely on is this invisible hand okay, and Naturally a lot of people are pretty skeptical about something like this that we could trust business people To treat their workers and to treat their customers in the best possible way so as to provide even distribution of income in society and to produce the best possible products at the lowest possible prices to create full employment in the economy and maximized what we now call GDP or GNP and furthermore not only with this invisible hand taking care of everybody in Everybody in the economy everybody in society But that all's we had to do to grow economically and to increase prosperity is Simply all we had to do is want to be wealthier Okay, so this invisible hand that Smith talks about It's kind of suspicious a Lot of people don't trust this idea that all we have to do is let business people Follow their self-interest Because naturally we think well if they follow their self-interest they don't want to pay workers They'd rather have free workers. They don't want to make the best possible products It takes too much effort And so despite the fact that the invisible hand is something that's been prominent in economics It's also something that people have been highly suspicious of to this day The businessmen or business people, you know cheat their workers they cheat their Stock owners they Do bad by their customers and so forth Well in the last few years I've been working on a an older economist than Adam Smith Actually guy named Richard Cantio who was a banker in Paris and was at the time the wealthiest individual private individual in the world and he wrote a book About the economy was the first book about economics and it was came out before Adam Smith And what I found in there That hadn't been found for a couple of hundred years was an actual description of what the invisible hand was Because Smith didn't elaborate. He just Said an invisible hand will take care of it but Cantio went through and looked at the sort of the nuts and bolts of the process of Where this invisible hand was and what it really meant and so in a couple of chapters in This book Contains the mechanism of how the invisible hand actually works and why it works so that the marketplace is indeed a self-regulated Institution and so what he says is that okay back in the days of feudalism one person Owned vast estates and everybody else had to work for this one person And then Cantio says well as time has progressed these vast estates have been broken up into individual farms and The estate owner or the king or the the ruler of these areas would divide up his vast estates into farms Into individual properties for individual farmers who would pay rent and Then those farmers would grow crops and produce products, which would then be sold in the marketplace for money and That as the tastes of consumers Changed from one product to another Prices would change as a result so that if people demanded more Carriages or things of that nature than more horses would have to be raised and the price of hay would go would increase and As a consequence the the price system would be such that it would direct resources To the direction in which consumers wanted those products Ultimately these individual farmers and entrepreneurs would have to Participate in this price system and some of them would succeed and others would fail Some farmers and entrepreneurs and craftsmen would make profits and others would make losses The ones who made profits would thrive and expand and those who made losses Would shrink maybe go out of business So the mechanisms underneath The market economy which are driving the invisible hand are things like private property as individuals started to own property The use of sound money which in that his day was silver coins Markets where goods and services are traded in exchange Prices which indicate products which are increasing in price and products that are decreasing in price and then finally Profit and loss the ultimate Foundation of the workings of the market economy is that some Business people farmers producers craftsmen would make profits and that would signal their success and that they could expand their businesses and other Entrepreneurs farmers craftsmen would make losses and have to go out of business They go bankrupt and have to get a job in some other industry. So there actually is Mechanisms that back up this invisible hand that it's not just hand waving. It's not just invisible It is tangible that the things like property rights sound money markets prices profit and loss Wealth and bankruptcy are very real in the real world And it's what makes the market economy a self-regulating automatic system by which the interests of everyone are taken into account as workers as owners as consumers and we can see this in The real world because Smith's mess message about the invisible hand is is that the marketplace the free market Can be self-regulated? It doesn't need government regulation and in fact Smith points out elsewhere in his book the wealth of nation Is that if we regulate Certain businesses that it can cause a lot of problems So if we look around today at our economy and at the world economy and we look at Industries markets that are regulated and industries in markets that are not regulated What we find is that the regulated markets are actually the ones with the most problems Okay, so with computers laptops televisions tomato juice Whatever flip-flops Hardly any regulation whatsoever Hard to imagine almost no regulation on flip-flops and yet they're super abundant. They're low-cost They're almost seemingly an infant infinite variety of these flip-flops and no government regulation and then when we look at regulated markets where the government is supposed to be protecting us and Protecting our property and protecting our environment and protecting our wealth We find the most problems For example the regulation of banking which we're having a lot of trouble with Nowadays the in terms of the big banks in New York and our money things of that nature and you hear a lot of people Saying well, we just need to regulate that stuff. We just need stricter regulations Well, the simple fact of the matter is is that banking the stock market and money are all highly regulated You've got state regulators. You've got federal regulators. You've got the Federal Reserve regulating it You've got the Comptroller of the currency Regulating these financial markets. You've got the Securities and Exchange Commission Regulating these markets. We've got multiple multiple layers of regulations on The mark on that market of money and banking and securities and that's where we see the most problems Regulations and I was a regulator myself Regulate regulation is more of a confidence game Government regulators never really Solve the problem. They never really Prevent bad things from happening. They are there just to give us confidence That somebody's looking out after them that somebody's keeping track of everything and that's simply not the case Smith's invisible hand is what gives us real and true regulation of the economy and government regulators are simply a confidence game Now pencils you all have probably picked up a pencil when you came in here and there's really nothing more Simple than a pencil in our economy. It's sort of almost outdated. I went into the grocery store of all places Last weekend to get a pencil for a particular I was filling out a scantron sheet for an exam And I didn't have a pencil so I went to the grocery store for a pencil and I got 20 pencils for 50 cents They were on sale But that's a really a great bargain And yet in reality No, one person knows how to make a pencil as simple as this is and His low cost is a pencil is no one person can make a pencil It's composed of a variety of parts It's got an eraser a little metal cap Not sure why they have that cap there and then there's wood and paint lettering Graphite in the middle and each stage of production is very complex in and of itself Okay, so it's probably the case that no one even knows how to make the paint that goes on the outside of the pencil or Knows where all the ingredients for that paint came from Likewise with the wood likewise with the eraser Likewise with the graphite Each of the ingredients in here come from different countries different continents Produced by a variety of different people So that it may take in full total tens of thousands of people working independently and cooperatively and competitively in order to bring about a pencil Okay, so the the people who Produce the graphite may have no idea about who and where the eraser was made and Then when you bring all the ingredients together into a factory to produce it Of course, the factory uses all sorts of complex machinery and each of those machines was produced by different companies who were using different inputs Again from different other firms And so the whole complexity of What goes into making a pencil It's precisely that complexity Which brings down the cost To something that we can just give away for free you guys can take those pencils home So the complexity actually Lends itself to Progress lower cost lower price and so what we see in the tendency in the marketplace is that over time the process of production and distribution becomes more and more complex and The ultimate cost Comes down and down and down so that the longer a product is around The lower the price of the product to the ultimate consumer very often a higher quality product as well so The point of the pencil story is that there's a tremendous complexity in the market economy Far beyond what we can actually know if you spend a year Studying a particular marketplace you might be able to get a good handle on Exactly who is involved in the production of something and what this means is that we are mutually Interdependent upon one another that we all depend upon each other in ways in which we cannot imagine now lately there's been an Uproar about all of our manufacturing jobs going to China and when people find out that the iPhone is made in China They can't believe it The iPhone is made in China the six hundred dollar iPhone Which is the real selling cost you get a discount if you subscribe to a service is Made in China actually It's only assembled in China The parts which go into an iPhone come from over 30 different companies in Like 13 different countries and all of those pieces are sent to China and Assembled there and then shipped to the United States Where we buy them up the parts that go into an iPhone That come from more than a dozen different countries cost about a hundred and eighty dollars For the six hundred dollar iPhone China gets about ten dollars for assembling the iPhone. So when Apple sells an iPhone It makes about four hundred and ten dollars of revenue not profit, but of revenue All of the jobs in terms of assembling the iPhone in China are not high-paying jobs the high-paying jobs are back in Cupertino, California at Apple The people who come up with the ideas the people who come up with the designs as well as the people who come up with the sales strategy Are the ones that are getting the high-paying jobs So we've got tens and tens and tens of thousands of people in the United States who are making upper Middle-income and high-income salaries Based on the iPhone and it's been estimated that if we took the jobs of making the parts for the iPhone and we took the Jobs in China of assembling the iPhone and we forced them all to come back to the United States That the iPhone would cost somewhere between twelve hundred and fifteen hundred dollars okay, so the idea of Shipping jobs out to China is Actually a great idea We don't lose jobs By shipping jobs to China we actually Increase the number of jobs and we increase the incomes of the people who are producing the high-value jobs of design of prototyping of sales and marketing strategies Distribution those are all high-paying jobs where the jobs of putting little pieces together over China are not high-paying jobs And finally the broken window Well, the broken window is a story about a little boy a Bad little boy who throws a stone through a shopkeeper's window and breaks it and there's a large crashing sound and all of the Neighboring businesses and households come out into the street To look at what this bad little boy has done He's broken the window the shopkeeper Has to call in the window guy to fix the window and somebody says at this gathering says well I mean that's you know, this is the silver lining of the story is the guy who fixes the window Now is going to make three hundred dollars and then that guy With the three hundred dollars is going to go out and spend that money at somebody else's store and Then the guy that store owner is now got three hundred dollars. He can go buy an iPhone or whatever and so that three hundred dollars just keeps on circulating around the economy creating employment for all these people and so what we need To do is to hire Find some bad little boys To go around breaking everybody's windows. I Mean think of it. We've got a big pile of rocks out there and if we all Got those rocks and started walking into downtown Auburn smashing everybody's windows Think of all the employment that we'd have everybody would be making tons of money Of course, that's ludicrous I mean, it's sort of there's a silver lining to it, you know, somebody's going to make the guy who Fixes the windows is going to make some money but you can't Move an economy towards prosperity Through destruction And I have to admit my fellow economists are some of the worst at this fallacy That you can create prosperity by destruction Because no matter what kind of natural disaster Hits if it's a tornado It's a hurricane if it's an earthquake or some kind of other natural disaster and Everybody's lamenting the destruction of property and the loss of life and the injuries Eventually they'll bring some Economist out onto the in front of the TV camera and they'll say Yeah, it's all such a shame, but it's going to create jobs Because of all this destruction you're gonna have to rebuild everything and that's the fallacy It doesn't create jobs It doesn't make us better off It seems as if it's creating jobs because we can see people being hired to fix those broken windows But the reality is is that the person who had to pay for that broken window would have spent the money in some way in Any case so that we would have that spending and that employment plus the windows So this parable comes to us from a French economist 150 years ago named Frederick Bastiat and He was constantly pressing the idea of the difference between what is seen and what is obvious And what is not seen and what is not so obvious, but upon reflection is obviously true We can't Create prosperity Through destruction We have to look beyond the broken window and realize that that shopkeeper would have spent that $300 in some way or another Buying goods buying services Improving the business hiring more workers Buying better machinery to create his products or services So that money would have been spent on something Because as you all know You always spend your money in some way You might save it in a bank, but then somebody's going to borrow that money and Spend it so all the money is eventually spent Bastiat's story Tells us to be vigilant Against government policies that seem to create jobs So he argues against the idea of trying to protect jobs through tariffs and protectionism he argues against the idea of Just using government money to create jobs for jobs sake He argues against the idea of immigration restrictions to protect domestic jobs Because immigration actually increases jobs. It doesn't decrease jobs It argues against things like cash for clunkers Remember the policy last year where if you brought your clunker in The government would give you a bunch of money and then the government would destroy that vehicle So the idea is we can create the sale of automobiles Jobs in the automobile industry by destroying existing Automobiles Okay, so it it never did create jobs. It was a temporary blip in automobile sales But it didn't do anything for the long-run health of the US economy So like Bastiat remain vigilant against the fallacy of the broken window. Thank you very much